SRS Products v LG Engineering

• Decision Date: 10 June 1999
• Parties: <!--994 S.W.2d 380 (Tex.App.-Houston 1999) SRS PRODUCTS CO., INC., Appellant v. LG ENGINEERING CO., LTD. and HERITAGE BANK, Appellees NO. 14-98-00938-CV In The Fourteenth Court of Appeals
• Court: Texas Court of Appeals

Page 380

994 S.W.2d 380 (Tex.App.-Houston[14th Dist.] 1999)

SRS PRODUCTS CO., INC., Appellant v LG ENGINEERING CO., LTD. and HERITAGE BANK, Appellees

NO. 14-98-00938-CV

In The Fourteenth Court of Appeals

June 10, 1999

On Appeal from the 151st District Court, Harris County, Texas, Trial Court Cause No. 98-23632

[Copyrighted Material Omitted] Panel consists of Justices Yates, Fowler, and Frost.

O P I N I O N

KEM THOMPSON FROST, Justice.

This is an accelerated appeal from the trial court's denial of an application for a temporary injunction to enjoin the payment and presentment of a standby letter of credit. Appellant SRS Products Co., Inc. ("SRS") requested a temporary restraining order and a temporary injunction preventing appellee Heritage Bank from paying on a standby letter of credit presented by appellee LG Engineering Co., Ltd ("LGE"). The trial court granted the temporary restraining order, but denied the temporary injunction. SRS appealed and we granted a temporary injunction preventing payment on the letter of credit during the pendency of this appeal. We affirm the trial court's denial of the temporary injunction and dissolve our temporary injunction.

Factual and Procedural Background

In August 1996, LGE contracted with SRS to purchase a commercial refrigeration unit for use by Thai Plastics Corporation, in Thailand. SRS contracted to design and construct the unit and guaranteed that all materials furnished would conform to LGE's specifications and drawings. SRS also guaranteed that the unit would be fit and sufficient for the purpose for which it was intended, of new and good materials, design and workmanship, and free from defects. LGE agreed to pay in excess of $2.4 million for the unit. SRS agreed to repair or replace free of cost to LGE any part or parts that failed "in the normal use and service and under proper operation, because of faulty design or workmanship or defective materials, within twelve (12) months after being placed in normal operation or within eighteen (18) months from the date of shipment, whichever is sooner, unless otherwise expressly stated in the body of this order." The parties amended the warranty period to make the warranty effective for two years fromthe date of shipment, or fifteen months after the date of final acceptance.

Originally, the parties' contract called for SRS to issue a performance bond in the amount of ten percent of the contract price to secure its warranty obligations to LGE. At SRS' request, however, LGE agreed to allow SRS to post a standby letter of credit in place of a performance bond, with the only proviso for drawing against it being a written declaration by an executive officer of LGE that SRS had "refused or failed to perform [warranty work] in accordance with the terms and conditions of [LGE's] Purchase Order" for the refrigeration unit. SRS arranged for Heritage Bank to issue a standby letter of credit for $240,147 (10% of the contract price) to cover the cost of potential warranty repairs.¹ After Heritage Bank issued the letter of credit, LGE released a final payment of over $800,000 to SRS.

The refrigeration unit arrived in Thailand in early September 1997. From the outset, LGE experienced numerous and sundry problems with the unit, including misalignment of the gearbox-motor compressor unit, misalignment of shafts and motors, skid bolt openings, severe vibrations in the compressor and other component parts, defective welds on piping, and improper functioning of the controller unit. When LGE called on SRS to make the necessary repairs under the warranty, SRS took the position that the defects occurred in the "delivery and installation phase" and that the warranty covered only defects occurring in the "operational phase." SRS sent repair personnel to Thailand only on condition that LGE pay in advance for their services. Despite repeated efforts to repair and replace the non-working parts, the unit would not function. In December 1997, SRS notified LGE that because LGE (or third parties acting at LGE's direction) had worked on, changed, or modified the unit, the warranty was void.

In May 1998, LGE made a demand on the standby letter of credit, providing Heritage Bank with the written declaration that SRS had failed or refused to perform warranty work on the unit. Under the terms of the letter of credit, Heritage Bank had five days to respond. Before the fifth day, SRS filed suit in the 151st Judicial District Court of Harris County, seeking a temporary restraining order, a temporary injunction and a permanent injunction preventing Heritage Bank from honoring the letter of credit and prohibiting LGE from making demand on it. The ancillary judge granted a temporary restraining order. After a two day hearing in July 1998, at which both sides presented evidence and made arguments, the trial court denied SRS' application for temporary injunction. SRS filed this accelerated appeal and sought injunctive relief from this court during the pendency of the appeal. On August 27, 1998, we granted a temporary injunction blocking payment on the letter of credit pending the decision of this court.

Standard of Review

The denial of a temporary or permanent injunction is within the sound discretion of the trial court. See Walling v. Metcalfe, 863 S.W.2d 56, 58 (Tex. 1993). Our review of the trial court's action is limited to determining whether the action constituted a clear abuse of discretion. See id. A trial court abuses its discretion by (1) acting arbitrarily and unreasonably, without reference to guiding rules or principles, or (2) misapplying the law to the established facts of the case. See Downer v. Aquamarine Operators, Inc., 701 S.W.2d 238, 241-42 (Tex. 1985), cert. denied, 476 U.S. 1159 (1986). An abuse of discretion does not exist where the trial court bases its decision on conflicting evidence and evidence appears in the record which reasonably supports the trial court's decision. See Davis v. Huey, 571 S.W.2d 859, 862 (Tex. 1978).

The Independence Principle Underlying Letters of Credit

A letter of credit is an engagement by its issuer to honor demands for payment by the beneficiary upon compliance with the conditions specified in the letter. TEX. BUS. & COM. CODE ANN. 5.103(a)(1) (Vernon 1994 & Supp. 1998). "The purpose of a letter of credit is to assure payment when its own conditions have been met, irrespective of disputes that may arise between the parties concerning performance of other agreements which comprise the underlying transaction." Sun Marine Terminals, Inc. v. Artoc Bank and Trust, Ltd., 797 S.W.2d 7, 10 (Tex. 1990). This principle of independence is the central feature of a letter of credit and is essential to its commercial viability.

Unlike the obligation of a guarantor, which generally does not mature unless the principal debtor has actually defaulted, the facts of the underlying transaction are generally not relevant to the obligation of an issuer of a letter of credit. An issuer's obligation to pay is triggered when the beneficiary presents documents that conform to the terms of the letter of credit. TEX. BUS. & COM. CODE ANN. 5.114(a) (Vernon 1994 & Supp. 1998). Except in very rare circumstances, courts will not recognize defenses or claims of the account party against the beneficiary as grounds for enjoining presentment or payment on a letter of credit.

The general rule is that an injunction will not issue to block payment of a letter of credit where the beneficiary has presented conforming documents. The Uniform Commercial Code, as adopted in Texas, recognizes only three instances in which a court may enjoin the honoring of an otherwise conforming letter of credit: (i) when documents appear on their face to comply with the terms of a credit, but a required document does not in fact conform; or (ii) when documents appear on their face to comply with the terms of a credit but a required document is in fact forged; or (iii) when there is fraud in the transaction. See TEX. BUS. & COM. CODE ANN. 5.114(b); AIG Risk Management v. Motel 6 Operating L.P., 960 S.W.2d 301, 305 (Tex. App.-Corpus Christi 1997, no writ). Here, SRS does not claim that the written declaration LGE made to Heritage Bank was nonconforming, nor does SRS otherwise dispute that LGE made the requisite presentation to Heritage Bank to draw on the letter of credit; rather, SRS contends that LGE's declaration was false and, therefore, constitutes fraud that vitiates the entire transaction, entitling it to injunctive relief under section 5.114(b), Texas Business and Commerce Code.

Requisite Showing for "Fraud in the Transaction" Under U.C.C. Section 5.114(b)

SRS argues that LGE's presentment to Heritage Bank was fraudulent because LGE knew, or should have known, (1) that the problems for which it sought repairs and replacement were not, in fact, warranty obligations because they occurred in the "installation phase of the project and not in normal use and service and under proper operations as required by the warranty;" and (2) that LGE's material modifications to the unit voided the warranty obligations altogether. SRS contends that although LGE made the requisite representation that SRS had defaulted in its warranty obligations, "it was not an honest representation" and therefore, the...